On December 15, 2021 the SEC proposed extensive amendments to Rule 10b5-1 that would, among other things, impose a cooling-off period for directors and officers buying and selling shares and require personal certification when they do so.
Officers and directors of public companies – that is, insiders – frequently use Rule 10b5-1 trading plans to buy or sell a predetermined number of shares of their own companies at a predetermined time.
The intention is that trading decisions are made when insiders are not in possession of material non-public information related to the stock. In doing so, they provide an affirmative defense to liability under the rule for insider trading and address the market’s concerns about such activity.
Although the rules governing the implementation and adoption of the 10b5-1 plans are relatively straightforward, the SEC proposal is based on the belief that there are gaps related to setting up plans and timing trades.
Specifically, there are no existing disclosure requirements when a 10b5-1 plan is adopted, modified or terminated. It is only required that such a plan is adopted when the participant is not aware of any material non-public information. In addition, there is no required waiting period before a stock transaction can take place.
The proposed amendments would apply to all domestic and foreign issuers, including smaller reporting companies and emerging growth companies. The proposals include:
- A mandatory 120-day/30-day cooling off period – At present it is possible to adopt a trading plan and buy or sell shares on the same day. Many plans customarily include a 30-day cooling-off period – a time between the plan’s implementation and the first trade under the plan. The SEC is seeking to implement a 120-day cooling-off period for section 16 officers and investors that are directly or indirectly beneficial owners of more than 10 percent of a company as well as a 30-day cooling-off period for issuers
- Mandatory certification – Under the proposed rule changes, officers and directors would be required to personally certify that they are not aware of any material non-public information and are adopting the plan in good faith. Most brokerage firms’ 10b5-1 templates already require a similar certification from individuals setting up the plan, but it is not currently required by the SEC
- Overlapping trades exception – If the changes are adopted, the affirmative defense under Rule 10b5-1 would be available to multiple overlapping trading plans for open market trades in the same class of securities
- Restriction on single-trade plans – Under the proposed changes, the affirmative defense for a single-traded plan would be available only if it is the sole trade during any 12-month period
- Disclosures – The proposed amendments would require extensive additional disclosures in annual reports on Form 10Ks and quarterly reports on Form 10Qs related to the adoption, termination or amendments of a 10b5-1 plan, insider trading policies and option grant policies
- Section 16 filings – In December 2020 the SEC proposed rules that would add a checkbox to Forms 4 and 5 for section 16 filers to report, on a voluntary basis, whether a purchase or sale was made under a Rule 10b5-1 plan. The SEC is now proposing to make this disclosure mandatory and to require inclusion of the adoption date of such a plan. The SEC is also proposing to add a second checkbox to Forms 4 and 5 for section 16 filers to disclose whether the transaction was made under a pre-planned contract, instruction or written plan that was not intended to satisfy Rule 10b5-1
- Bona fide gifts of securities – At present, bona fide gifts made by section 16 officers or directors are subject to voluntary reporting on Form 4 or to delayed reporting on Form 5 after the issuer’s fiscal year-end. The SEC is now proposing that insiders report bona fide gifts of equity securities exclusively on Form 4 within two business days of the transaction.
Under the proposed amendments, employees using 10b5-1 arrangements to ‘sell to cover’ shares underlying equity awards to satisfy tax-withholding obligations may no longer be able to use the affirmative defense attached to 10b5-1 plans for the sale of any other securities of the issuer.
The SEC has requested comments on how the overlapping plan restriction might impact tax withholding for equity awards, and it is possible the SEC will address that issue in the final rules by exempting tax-withholding transactions from the limitations on overlapping plans, given the same concerns regarding potentially abusive practices do not exist for ‘sell to cover’ transactions that are intended only to satisfy tax-withholding obligations.
Preparing for the changes
The changes are subject to a 45-day comment period and it is not clear whether the final rules will differ from the original proposal. If adopted in their current form, however, the changes would be a notable departure from established 10b5-1 practices. For this reason, companies should start reviewing their existing 10b5-1 plan guidelines and consider how the changes might affect them.
Specifically, companies should review the following provisions of their insider-trading policies:
- Provisions related to cooling-off periods and other plan restrictions
- Trading window provisions and pre-clearance procedures, as well as appropriate remedial measures related to non-compliance with such provisions
- Provisions related to gifts of securities to section 16 filers to ensure that proper former disclosure policies and practices are adopted, if necessary
- Companies should begin to think how they would disclose and describe their insider-trading policies and whether any amendments are required to strengthen or clarify existing provisions
- Companies that grant stock options may also want to review their existing equity grant policies and discuss with their counsel whether any formal polices or practices should be adopted to address the disclosures required under the proposed rules
- If the new disclosure obligations regarding insider-trading policies are adopted, companies may want to consider updating their sub-certification process to cover these new disclosures, which would be subject to the officer certifications required by section 302 of the Sarbanes-Oxley Act of 2002.
Cynthia Krus is executive partner, Stephani Hildebrandt is a partner and Krystyna Blokhina Gilkis is an associate with Eversheds Sutherland